IN PATENT DISPUTES, CPA
LITIGATION CONSULTANTS help
patent holders demonstrate that “but for”
an infringement they could have sold more
of their product. Quantifying damages in
patent infringement cases can be the focus
of a forensic and litigation services
practice.

THE PANDUIT CASE PROVIDED FOUR QUESTIONS
CPA litigation consultants had
to address: Is there demand for the
patented product? Are there acceptable
noninfringing alternatives to the
infringing product? Does the patent
holder have the manufacturing and
marketing capacity to make and sell more
of the product? Can the damages
consultant quantify the lost profits to
a reasonable degree of certainty?

THE BREAD AND BUTTER FOR
CPA litigation consultants is
the ability to quantify the actual lost
sales and the lost profits related to
those sales. In damages consulting CPAs
must begin the analyses by assessing the
revenues lost because of the
infringement.

THE LAW HAS CHANGED SINCE
THE PANDUIT CASE. It now is
possible to receive an award of lost
profits based on a patentee’s market
share—despite the presence of acceptable
noninfringing alternatives in the
marketplace—for related products not
actually covered by the patent in
question.

LITIGATION CONSULTANTS
SHOULD CONSIDER other damages
that may have resulted from the alleged
infringement, such as collateral sales
or erosion of prices.

GLENN NEWMAN, CPA, CFE,
is a principal at Parente Randolph, LLC,
Philadelphia, where he heads the forensic
accounting and litigation services group.
He is a member of the firm’s executive
committee and serves on the AICPA Forensic
and Litigation Services Committee. His
e-mail address is
gnewman@parentenet.com . RICHARD J.
GERING, PhD, principal at Parente
Randolph, provides consulting assistance
including economic and statistical
analyses related to commercial disputes.
He teaches litigation strategy at
Villanova University School of Law. His
e-mail address is rgering@parentenet.com
.

he jury finds the plaintiff’s patent
to be valid and infringed and awards damages in
the amount of….”

In recent years juries
increasingly have delivered some variation of this
message. A spike in lawsuits alleging
infringements of intellectual property (IP)
rights, usually in the area of patents, has
created a niche for CPA litigation consultants who
provide in-depth detailed financial analyses to
calculate economic damages and give testimony as
expert witnesses. Often the disputes are
“bet-the-company” matters that can force an
infringer to stop manufacturing or selling its top
products. A finding of infringement also may open
up an exclusive market for a patent holder’s
products without fear of violating antitrust laws.
Those are very high stakes.

Patent
holders may be entitled to lost profits
if they can demonstrate that “but for”
an infringement they would have sold
more of a product than they did during
the affected time frame.

Specifically, federal law (USC title 35,
section 284) provides for the recovery of damages
resulting from a patent infringement. It says, in
part, that “upon finding for the claimant, the
Court shall award the claimant damages adequate to
compensate for the infringement, but in no event
less than a reasonable royalty.” Over time an
extensive case law road map has developed to
clarify the code and its relationship to changing
technology and business practices. In most patent
disputes the lead attorney hires a CPA and/or
other experts to analyze, quantify and report on
the potential damages suffered by the patent
holder. This article will address relevant issues
for CPA litigation consultants when evaluating
lost profits from patent infringements (for more
information see “
20 Steps for Pricing a Patent ”).

Guidelines
From Georgia-Pacific

The court used these 15
factors—paraphrased here—to determine the
type of monetary payments that would
compensate for a patent infringement in
Georgia-Pacific Corp. v.
United States Plywood Corp.,
318 FSupp 1116, 6 USPQ 235 (SD NY
1970):

The royalties received by
Georgia-Pacific for licensing the
patent, proving or tending to prove an
established royalty.

The rates paid by the
licensee for the use of other similar
patents.

The nature and scope of the
license, such as whether it is exclusive
or nonexclusive, restricted or
nonrestricted in terms of territory or
customers.

Georgia-Pacific’s policy of
maintaining its patent monopoly by
licensing the use of the invention only
under special conditions designed to
preserve the monopoly.

The commercial relationship
between Georgia-Pacific and licensees,
such as whether they are competitors in
the same territory in the same line of
business or whether they are inventor
and promoter.

The effect of selling the
patented specialty in promoting sales of
other Georgia-Pacific products; the
existing value of the invention to
Georgia-Pacific as a generator of sales
of nonpatented items; and the extent of
such derivative or “convoyed” sales.

The duration of the patent
and the term of the license.

The established profitability
of the patented product, its commercial
success and its current popularity.

The utility and advantages
of the patent property over any old
modes or devices that had been used.

The nature of the patented
invention, its character in the
commercial embodiment owned and produced
by the licensor, and the benefits to
those who used it.

The extent to which the
infringer used the invention and any
evidence probative of the value of that
use.

The portion of the profit
or selling price that is customary in
the particular business or in comparable
businesses.

The portion of the
realizable profit that should be
credited to the invention as
distinguished from any nonpatented
elements, manufacturing process,
business risks or significant features
or improvements added by the infringer.

The opinion testimony of
qualified experts.

The amount that
Georgia-Pacific and a licensee would
have agreed upon at the time the
infringement began if they had
reasonably and voluntarily tried to
reach an agreement.

CASE LAW GUIDELINES
Patent holders may be
entitled to lost profits if they can demonstrate
that “but for” an infringement they would have
sold more of a product than they did during the
affected time frame. The 1978 Panduit
case provided a four-factor approach that has
been widely accepted as identifying the key issues
necessary for a recovery of lost-profits damages
(see “ Case Citations ”). CPA
litigation consultants assessing lost profits
should discuss with counsel both Panduit
and subsequent case law.

The four ( Panduit ) questions CPA
litigation consultants address are: Is there
demand for the patented product? Are there
acceptable noninfringing alternatives to the
infringing product? Does the patent holder have
the manufacturing and marketing capacity to make
and sell more of the product? Can the damages
consultant quantify the lost profits to a
reasonable degree of certainty? To perform patent
infringement lost-profits analyses, practitioners
need to research the following:

Is there demand for the patented
product? Practitioners will
analyze sales data, contemporaneous business
records and plans related to the product’s launch,
marketing and promotion to help the team (lead
attorney, CPA and/or other experts) demonstrate a
demand for the patented product. Depending on the
specific facts and circumstances, demand may apply
to a feature within the product or to the product
itself. If it is merely a feature, then the
damages specialist for that case (who may be the
CPA, a marketing analyst or another type of
expert) needs to consider whether there is a link
between the patented feature and customer demand
and, if so, demonstrate that it is an important
factor in the purchase of the product.

Are there acceptable noninfringing
alternatives to the infringing product?
At one time a damages consultant’s
infringement analysis by and large consisted of
verifying whether there were noninfringing product
alternatives in the marketplace. If there were
noninfringing substitutes, the law held that the
patent holder wasn’t entitled to damages in the
form of lost profits. However, this point has
evolved as the marketplace has become more
complex, and under some circumstances the law
allows for lost profits when there are
alternatives or substitutes.

Does the patent holder have the
manufacturing and marketing capacity to make
and sell more of the product?
Assuming there’s demand for the
patented product and there are no acceptable
noninfringing alternatives, CPA damages
consultants need to demonstrate the patent holder
can both manufacture and market the product.
(That’s the basis for asserting profits have been
lost.) Typically, the damages specialist should
consider current production levels, past
manufacturing expansions and any plans for future
growth to demonstrate manufacturing capacity. In
some industries, such as pharmaceuticals,
understanding the sector’s regulatory framework is
an important factor. For example, a business with
the plant capacity to make a product that it
doesn’t have regulatory approval to sell does not
meet the “but for” test necessary to obtain
lost-profits damages.

After addressing
manufacturing capacity, damages specialists also
must look at whether the patent holder could have
sold the additional product it would have
manufactured. This typically is done by assessing
the channels of distribution, geographic markets,
common customers, and the size and nature of the
patent holder’s and the infringer’s sales forces.
Analysis of working capital and interviews with
key personnel also will help show whether the
patent holder had the financial and management
capacity to generate the additional sales.

Can the lost profits be quantified to a
reasonable degree of certainty?
This is the bread and butter for the
CPA litigation consultant: the ability to quantify
the actual lost sales and the related lost
profits. To quantify lost profits, damages
specialists must subtract from the projected lost
sales all the incremental costs necessary to
manufacture, market and sell the additional
products that could have been produced “but for”
the infringement. Typically, this means performing
an analysis to arrive at the incremental
margin—the difference between the top-line and
bottom-line figures (see “
Innovator v. Copycat ”).

10
Largest Patent-Damages Awards

Polaroid Corp
v. Eastman
Kodak

$873.2 million

IGEN
International, Inc.
v. Roche
Diagnostics, GmbH

$505
million

City
of Hope National
Medical Center
v. Genentech,
Inc.

$500.1 million

Haworth, Inc.
v. Steelcase,
Inc.

$211.5 million

Hughes Tool
Company v.
Smith
International, Inc.

$204.8
million

Procter &
Gamble Co. v.
Paragon Trade
Brands, Inc.

$178.4
million

Exxon
Corp. v.
Mobil Oil Corp.

$171
million

Advanced
Cardiovascular
Systems, Inc.
v. Medtronic
AVE

$166.7 million

Viskase Corp.
v. American
National Can Co.

$164.9
million

Hughes Aircraft
Corp. v.
United States

$154
million

Source: Intellectual Property
Today, March 2003.

WHAT'S THE LAW NOW? The first two factors in the Panduit
case have evolved over the years, and it now
is possible to obtain lost profits

Based on a patentee’s market share,
despite the presence of acceptable noninfringing
alternatives in the marketplace.

For related products not actually
covered by the patent in question.

But
lost profits are not appropriate if a
noninfringing alternative would have been
available to market with minimal effort.

How does “market share”relate?
Based on the 1989 Mor-Flo
case, a patent holder is entitled to lost
profits, even though acceptable noninfringing
alternatives are available in the market at the
time of infringement. Under Mor-Flo
guidelines patent holders may claim lost
profits based on market share. That is, if three
companies’ products each have a one-third share of
the market and a patent’s validity and
infringement are established, the infringement
posits that both the patent holder and the company
with the noninfringing alternative would have
generated 50% of the infringing sales. The patent
holder’s damages would be lost profits on half of
the infringing units and a reasonable royalty on
the remaining half.

What is an “acceptable” alternative?
A refinement through case law
addresses which noninfringing alternatives are
acceptable. In Bic Windsurfing, the court
said an alternative is not acceptable if the
product is in a completely different price range
or category. For example, if a product is intended
for an introductory user rather than an advanced
user, a lost-profits claim still may be
appropriate. Thus, a product has to be not only
noninfringing from a technical perspective, but
also acceptable from an economic and consumer
perspective.

Do the patentee’s products have to be
covered by the patent? Is a
patent holder entitled to lost profits if the
infringing product competes with a product made by
the patent holder but not covered by the patent?
The 1995 Rite-Hite and King
Instruments cases dealt with this issue. If
it is “reasonably foreseeable” that but for the
infringement the patent holder would have sold
more of its product, it is entitled to lost
profits on those lost sales regardless of whether
the patent holder’s product is covered by the
patent at issue.

What is an “available” alternative?
Does a product have to be on the
market to be considered available? In the 1999
Grain Processing case, the alleged
infringer could have designed around the patent in
a couple of weeks using readily available
technology that was more expensive than the
patented process. The court held that because the
design-around option was “available” at the time
of infringement, the patent holder had no basis
for claiming it would have made more sales “but
for” the infringement and was not entitled to lost
profits. The court explained that a “but for”
analysis is hypothetical. Damages consultants must
effectively reconstruct what could reasonably be
expected to have happened in the marketplace,
including alternative actions the infringer could
have taken had it not infringed. That is, what
steps would a reasonable businessperson have
employed had the favored method not been
available?

PRACTICAL TIPS TO
REMEMBER

Ask counsel to
identify any recent case law
that has bearing on the damages
you’re being engaged to compute.

Remember, as the
damages specialist, you
haven’t been retained to
assess the validity of a
patent or its alleged
infringement—for your working
purposes, those key liability
points are assumed.

Identify all the
collateral products that may
be tied to the patented
product at issue (razors with
razor blades, for example).

When evaluating
potential alternatives, look
to the market.

Assess whether
the patent holder will have
the ability to raise prices
when the infringer is removed
from the scene.

Understand what
options the defendant could
have employed other than
infringing, such as a
design-around.

OTHER DAMAGES-RELATED ISSUES CPA litigation consultants should consider
other available damages that may have resulted
from the alleged infringement, including lost
profits on collateral sales and erosion of prices,
for example. Damages for both collateral
sales—sales of accessories to go with the
product—and price erosion may exceed damages for
lost profits. However, damages consultants must
understand the relevant case law and perform
thorough analyses to prevent opposing counsel from
calling their numbers “speculative.”

Understanding the reasonable royalty approach
will enable damages consultants to present
balanced alternative-damages computations. Because
federal law provides that patent damages can be no
less than a “reasonable royalty,” this calculation
generally is viewed as the damages “floor”
(minimum) in a patent infringement dispute.

COMMITMENT IS ESSENTIAL Quantifying damages in patent infringement
cases can be a key part of a forensic and
litigation services practice. The cases are
complex and challenging, and the damages awards
can be quite large. However, one should not dabble
in this field; it is neither a sideline business
nor for the faint of heart given the stakes
involved. It requires an investment in time to
understand the issues, the relevant cases and in
many instances a particular industry or
technology.

Innovator v. Copycat
In January 1995 Innovator developed
and patented a process for making a life-saving
drug, which it expected to launch in 1997 after
receiving FDA approval. In January 1996 Copycat
launched a competing drug, which Innovator claimed
infringed on its process. It sued Copycat for patent
infringement. Innovator launched its product in 1997
at $1 a pill, a price comparable with Copycat’s but
20% lower than the $1.20 launch price it had
originally planned.

Actual
Copycat sales

Actual Innovator sales

1996

$10 million

0

1997

$20 million

$ 5 million

1998

$30 million

$10 million

1999

$30
million

$15 million

Innovator’s
incremental profit margin was 80% and its net
profit margin was 20%. A third competitor offered
a noninfringing competing drug that had sales
identical to those of Innovator from 1997 to 1999,
for which it paid Innovator a royalty of 10%. So
without Copycat in the market, Innovator would
have had a market share of 50%.

Damages Lost profits. Based on the
fact that Innovator launched its product in 1997
and that its market share “but for” the sales of
Copycat would have been 50% of 1997 sales of $20
million ($10 million for Innovator and $10 million
for the third competitor), the damages would have
been calculated as follows:

Loss of revenues
(Copycat sales 1997–1999):

$80
million x 50% market share

= $40
million

Incremental costs saved
(1997–1999): 20%

– 8
million

$32 million

Price erosion. “But for”
the infringement, Innovator would have sold its
pills at $1.20 each instead of $1—a price
reduction of 20%. Copycat’s 1997–1999 sales of $80
million multiplied by Innovator’s 50% market share
plus Innovator’s actual sales of $30 million
equals total affected sales of $70 million,
multiplied by the price reduction of 20% equals
$14 million. There may be an argument the price
still would have been $1 a pill without Copycat
because of the third entrant into the market. If
so, there would have been no price erosion.

Reasonable royalty. $5
million: $50 million in Copycat sales that are not
included in the lost-profits calculation (1996
sales and 50% of sales from 1997 to 1999)
multiplied by the royalty rate of 10%.